Heightened risks threaten Brazil’s investment grade

By:
Jeremy Weltman
Published on:

Latin America’s largest market and one of its hottest investment prospects only a few years ago is now rocking from a confluence of negative factors undermining creditworthiness.

Brazilian investor risk continued to rise during the first half of this year, according to Euromoney’s country risk survey.

The sovereign’s risk score fell by 2.5 points to 56.5 out of a maximum 100 points, culminating in a seven-place drop in the global rankings, to 50th out of 186 countries surveyed.

That pushes Brazil deeper into tier three, the middle of ECR’s five categories commensurate with a credit rating towards the lower end of the BB+ to A- range.

Standard & Poor’s has this week adjusted its lowest triple-B rating of Brazil from stable to negative, putting pressure on the real.

Moody’s is one notch higher, and so is Fitch, but that might be about to change.

ECR survey data suggest it won’t be long before Brazil’s investment-grade status is withdrawn.

 

What’s wrong?

LatAm’s largest economy can’t seem to shake off its problems, having been affected by low commodity prices complicating the fiscal accounts and by monetary tightening required to stabilize the currency.

After grinding to a halt last year, the economy contracted in real terms during Q1 2015 and, moreover, retail sales fell sharply in April and May, signalling further disappointment in Q2.

Sales growth has been on a sliding trend for the past few years, but the May figure was the first to show a negative year-on-year result.

It signifies how rising unemployment and now 9% inflation pushing the Selic benchmark interest rate up to 13.75% are eroding consumer confidence and pointing to deep recession.

Sao Paolo-based Félix Larrañaga, a professor at the Universidade Nove de Julho, says, referring to these negatives: "The situation in Brazil is becoming worse."

Other economists concur.

Marijke Zewuster, head of emerging markets at ABN Amro, states: "Last year, we believed that confidence would return and ensure reasonable growth after the elections. However, the opposite is true, and the 1% contraction now expected for Brazil [this year] may even prove too rosy."

Contributors to the survey also include the  BBVA research team. It states:  "Our lower growth forecast (-1.3pp in 2015, to -0.7%) arises due to a stronger-than-expected macroeconomic adjustment, higher inflation and uncertainty overshadowing the crisis affecting Petrobras [the national oil company]."

Survey scores for the growth and employment risk indicators have been downgraded.

Not just economics

Brazil’s problems extend much wider than pure economics, as Larrañaga explains: "Corruption investigations are this week reaching top political leaders and the press is speculating that Luiz Inácio Lula da Silva [ex-president], Dilma Rousseff [current president], Eduardo Cunha [chamber president] and Renan Calheiros [senate president] will be included."

The scandal surrounds wrongdoing at Petrobras. Rousseff is also facing an investigation from the Tribunal de Contas da União – Federal Court of Accounts – for irregular administration of the 2014 budget.

Meanwhile, lower-house speaker Cunha has broken away from the governing coalition led by Dilma’s Workers’ Party and is threatening to take his party PMDB with him.

Other scandals are surfacing, further tarnishing the political establishment and raising questions over policy implementation. No fewer than 34 members of congress are accused of graft and Dilma’s own approval ratings are down to just 10%.

Scores for all six political risk indicators in Euromoney’s survey have been downgraded this year, notably government stability, falling 0.2 to 6.6 out of 10. Corruption is the lowest scoring of all with just 4.4 points awarded.

Structural risks in terms of Brazil’s soft infrastructure and its industrial relations have not escaped the downgrades either.

Grave implications

If Brazil’s problems worsen, the country’s investment-grade rating will be at risk.

Brazil is presently ranking on a similar scale to Botswana (47th in the survey), Italy (49th) and Uruguay (52nd) in terms of its total risk score.

 

All three are considered investment grades by the three main agencies, but Turkey (ranking 53rd) is only a speculative double B grade according to Standard & Poor’s.

Much will depend on whether the government can maintain a primary surplus sufficient enough to contain the debt accumulation.

The debt burden rose on a gross basis to 58.9% of GDP in 2014 – it is now more than 62% – and will reach an estimated 66% by the end of 2016, with the debt-servicing cost escalating if Brazil’s credit ratings fall.

Worryingly, finance minister Joaquim Levy has revised the primary surplus targets for 2015-17 downwards, with debt now unlikely to fall until 2018.

As BBVA notes: "The fiscal situation looking ahead is substantially bleaker now than it was a quarter ago – fiscal balance of -5.6% of GDP now, while it was -4.4% in January – which serves to illustrate the scale of the fiscal effort that is called for."

The government says it is committed to austerity and structural reform, including the sale of some public assets.